By Motoko Aizawa, Senior Fellow, Climate Bonds Initiative
A 45 MW power plant running on soybean and recycled cooking oils, enough solar panels to cover six football fields, and 7 MW worth of fuel cells – when Syracuse Industrial Development Agency issued, on behalf of developer Destiny USA, $228 million tax-exempt green bonds in 2007 to finance a massive addition to a shopping mall, these were the green promises. And they remained exactly that: just promises.
The US Internal Revenue Service (IRS) audited the developer to see whether the bond’s tax-exempt status should be revoked, but ruled that the bonds were in compliance. The lawyer representing the developer apparently said: “the bonds should be allowed to remain tax-exempt because the federal law creating the program only required it to describe the energy efficiency, renewable energy and sustainable design features planned for the project and did not require that the project actually include all of them.”
With the green bonds market swelling up and forecast to triple in size this year, we are also hearing murmurs about greenwashing. If we have another Syracuse-type situation, how would the law handle it today?
A number of practicing lawyers representing green bonds issuers and underwriters and legal experts came together recently in New York City to discuss this very topic. The event was hosted by Shearman & Sterling.
We began by asking about the state of play today. What are lawyers observing in their day-to-day practice?
The first observation, well known to the Climate Bonds blog readers, is that there is no legal definition of green bonds. When green bonds are issued, usually they are asserted as green with no common legal basis. We could be looking at nuclear, hydro or geothermal bonds, all with potentially serious climate consequences, and yet their green claims can go unchallenged. Apart from true project bonds, municipal bonds, and bonds issued by international financial institutions (IFIs), ordinary corporate green bonds usually have virtually no legal basis for the green claim: no ESG (environmental, social and governance) covenants, maintenance or reporting covenants, no green event of default, and no penalty. The exception to this is that in cases, we are seeing verification upfront and “second opinions”. The only control we currently have is the Green Bonds Principles, and yet there are no substantive criteria for what’s green in the Principles.
I asked: Do we know of any precedents on false or unfulfilled green promises? No, the only precedent, if we can call it that, was the Syracuse case mentioned above. And no one was aware of any cases coming out of impact investing, where investors agree to accept a lower financial return for measurable environmental or social outcomes. Part of the problem with green promises is that it may be quite difficult for the plaintiff to show actual damages.
In a series of US cases in multiple States in 2008-2010 the Dr Pepper Snapple Group was sued for misleading consumers by labeling their product sweetened with high-fructose syrup as “natural”. A federal court judge tossed out the law suit with a ruling that the plaintiffs failed to show that they paid more for the “natural” claim.
The Snapple case led us to wonder: Who will have jurisdiction over excessive or unfulfilled green promises in green bonds? We assume that in the US the SEC has exclusive jurisdiction over securities, which probably meant that the US Federal Trade Commission, for example, would not have jurisdiction. The SEC has been struggling with non-financial disclosure issues, such as disclosure around conflict minerals. In the future, it undoubtedly will have to deal with more of these issues, such as corporate disclosure of greenhouse gas emissions. Will it be able to cope? But the more immediate question is: Can a non-financial claim under Section 10(b)(5) generate legal liability?
Investors are pulling the green bonds market, and pension funds are among the more active purchasers of green bonds. Are they not in a position to demand the greening of green bonds?
Some lawyers at the meeting observed that they will go for green provided that the financial return is there; if the bonds’ financial performance is consistent, they probably would not mind too much even if green performance is lacking. The flip side is that investors are not likely to accept a lower rate of return on account of green due diligence that would cost 5 to 15 basis points. But do they not have to be educated on the best practices in order to make informed investment decisions?
What best practices are lawyers observing, then? Nearly everyone agreed that adherence to some kind of third party green standards or third party certification under those standards would constitute good practice. In addition, periodic reporting on green performance would be useful. So why can’t the issuer bundle green reporting into its required annual reporting? This will help grow the secondary market for green bonds, which is limited right now. Investors are holding on to their green investments, but without an ongoing reporting framework, can a secondary market develop?
We then asked: What should the legal community do? Here are some ideas that came up:
- Need a guidance document to explain to the issuer clients how to issue proper green bonds.
- Work with securities exchange to put in place guidance documents (e.g., work with the Ontario securities commission to bring about a guideline).
- Look at innovative structures, such as Yieldco’s.
- Meet regularly to share legal issues, perhaps in other jurisdictions too.
- Lawyers should focus on how to add value to their client and not focus on legal liability.
And what else needs to be done? Who else should be at the table?
- The Climate Bonds Initiative can help with some standardized formats for reporting back to CBI; also Climate Bonds blogs help focus on the “Pinocchio factor” upfront and play an important educational role.
- Pension funds are really pulling this market. The narrow interpretation of fiduciary duty in the US (as underscored by the Bush-era opinion letter) does not help. Get this changed.
- Would a green exchange help? There are already some up and running, e.g., Oslo, LSE, but nothing in the US yet. How about a green bond index? A few already exist, from S&PDJI, MSCI, Solactive and the Bank of America.
- Once standards are imposed, that will put a lid on the market, as it happened with the carbon markets. So let the green bonds market sort itself out over time; meanwhile it is important to build up a pipeline of low carbon assets and enable orderly transition and value creation.
- Need to have a similar discussion with issuers, banks, rating agencies, verifiers, ERISA lawyers. . . .
As a beginning conversation, this legal roundtable proved to be extremely helpful. We will be organizing a follow up lawyers-only discussion in London on 12 June.
We are also in the process of establishing an ongoing Legal Working Group; more details will follow. Meanwhile, if you would like to provide feedback and make suggestions, please contact info@climatebonds.net
